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How do you tax the residents of a virtual world? By Mark Simpson

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5th Sep 2007
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Mark Simpson tax planning director of chartered accountants Simpson Burgess Nash explores the challenging issues surrounding taxing profits made in virtual worlds.

Over the last year a joint economic committee (JEC) of the US Congress has been investigating the issues of taxing enterprises that exist simply on a server. Their findings will be published very shortly and will be read with interest, not only by the Internal Revenue Service (IRS) in the USA; their esteemed UK counterparts at HM Revenue and Customs (HMRC) will also be interested to see if there are opportunities to tax a new breed of online entrepreneur.

It might seem nonsensical and perhaps comical to seriously consider taxing a business that only really exists in binary on a server, you might think, but it certainly has revenue possibilities.

But before I venture further, what are virtual worlds and are the businesses that have prospered in their dimensions worth pursuing? Well, simply put they are rough online copies of our own society and that goes for their economies as well. Let’s take Second Life as an example. With 9 million user accounts, a tiger economy growing at 10-15% monthly and a GDP that is currently estimated at $600 million it is no wonder that the IRS is taking note. More so because the virtual currency, the Linden Dollar, can be exchanged at a rate pegged between $260 – $320 to its US equivalent. If it stills seems far-fetched, at the turn of the year, it was confirmed that Second Life had produced its first US (not Linden) Dollar millionaire, Ailin Graef.

But it is not going to be simple and straightforward for HMRC to act even if trends continue and large numbers of UK residents of virtual worlds start to make significant revenues. First, there are some hard questions that need to be answered:

Do you tax residents in the virtual world or after they have converted their money to recognised currencies? If HMRC taxed virtual profits it would have to accept payment in currencies such as Linden Dollars.

And the questions get much harder to answer:

Does virtual wealth form part of the estate in relation to inheritance tax? Is VAT payable on goods that in reality only exist on a computer server? You can ask the same question of capital gains. Domicile, my favourite, and the issue of where profits arise get more complicated: the virtual world is based in the US, your business bank account in Canada, and you live in Manchester. Interesting………

So will our HMRC act and if so how?

To quote Johnny Nash’s 60s hit, “There are more questions than answers.”

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Rebecca Benneyworth profile image
By Rebecca Benneyworth
07th Sep 2007 19:31

A similar theme
Nowhere near as complex, but some years ago I heard that my local tax office was interested in our local "alternative" economy. Stroud in Gloucestershire has quite a few unconventional people living here, and for many years a currency has operated on a semi formal basis (including "bank statements"), known as "Stroud pounds". It is a fully functioning barter currency which allows for eachange of skills between members. It was the subject of a half hour programme on Radio 4 a while ago.

Of course, those who supplied services for barter in exchange for non business supplies would gain a tax advantage, and I did hear that the local tax office was showing an interest! I'm not sure how far this went, and thankfully have never acted for clients in the barter system, but the virtual money problem is a sophisticated devlopment of the same issue. Measuring and taxing "money" earned in different forms.

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By carnmores
11th Sep 2007 18:39

Nichola
in future where ther is no transcript you should record the podcast using a digital ditaphone and then plug it into dragon

SIMON

i see the lawyers are already in secondlife - skip a lifetimes knowledge and double the fees?

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By AnonymousUser
10th Sep 2007 13:53

virtually
The question is which tax authority will be the first to open for business in Secondlife, and what its authority will be. I look forward eagerly to the Income Tax (virtualworlds) Bill 2008....

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By User deleted
10th Sep 2007 13:21

Virtual Assets for Tax?
having not played the 'game', I may not not be au-fait with the true goings on here, but it seems to me that what you could have is an 'asset' which may become tradeable in the real world.

If there was (maybe there is already??) a market (in the real world), and you sell the 'asset' for hard cash, then would it be a chargeable gain? I think maybe, Yes...and one with no base cost.

If you went on to do this on a regular basis, then I presume it could be attacked as trading and the profits taxed as income?

(I am assuming, of course, that all the 'money' mentioned in the article is locked in to the virtual world and, this being the case, you could only then have a virtual tax to match, as no one would pay out tax , in the form of hard cash, on what is a fictional income source, now would they)?

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By User deleted
10th Sep 2007 13:49

Nothing new under sun
I'm not totally up to speed on this virtual world business, but if it is spawning "real" millionaires there seem to be legally enforceable obligations in it ("choses in action" as they used to be called). I am not surprised the taxman is joining in and the demands won't be virtual! But maybe I just haven't got it.

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Richard Murphy
By Richard Murphy
10th Sep 2007 14:52

Not so complicated
I've already done interviews on this question.

The answer is simple: virtual worlds are just trading mechanisms, no more and no less. They just happen to involve currencies created by people other than governments and the trading takes place under what may often be artificial names in what looks like an artificial place. What's new? This is the tax haven world of front companies that are deemed to have no residence, after all.

Those names are, however, in the case of virtual worlds identifiable by the provider of that space and the location of that space can also be identified. It is where the server is. Exchange rates can be established, and are. In that case accounts can be attributed to owners and information requests can be made of the owner of that artificial space for that data to be supplied. Put bluntly, the owners are acting as banks by any other name.

Banks are regulated, world wide. So should these owners be so: if not they become the facilitators of money laundering mechanisms at the very least. Once that is established the duty to supply information becomes key. If they choose to operate in locations where information is not exchanged then this comes a simple assault by these facilities (and the governments that allow this to happen) on the financial establishment of the major nations of the world. Action to counter that would have to be taken. This is not impossible.

As for the taxation of the transactions: these transactions take place at the point where control of the transaction is located i.e. where the mouse is clicked. This is a well known concept: it is found in much corporate tax law world wide. In that context if the mouse that controls the transaction is in the UK then that's where the tax is due, that's where the capital gain arises and that's where the estate is located.

How do you prove that? Only by proving the location of the account. So we're back to proper know your client rules required of any financial establishment.

I see no other way forward.

And for Rebecca's comment on what are called LETS schemes (Local Exchange Trading Systems) (see http://www.letslinkuk.net/) agreements on such schemes have been negotiated with the Revenue.

Richard Murphy

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By User deleted
10th Sep 2007 16:42

Which tax authority will be the first?
My money is on the one which has the website:

www.irs.gov

Note that is does not contain a suffix that one might expect like .usa, clearly there is one tax service which already feels that they own the virtual world!

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By AnonymousUser
12th Sep 2007 19:11

Virtual Monopoly
If a group of people met regularly to play an extended game of Monopoly it would have no tax consequences.

If at the end of the game there were "prizes" based on the assets of the participants, would this not be gambling income and therefore free of tax?

If the rules permitted using real £ to buy additional Monopoly money which could be cashed in at any time would this change the gambling factor?

Is it not as simple as that?

For IHT though the pot will be an asset and fall into the deceased's estate.

Shame really , I understand that the Avatars can buy "enhanced" body parts, I was looking forward to some surreal arguments as to how we account for the expense!

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